Imperial Tobacco's (IMT) preliminary results for fiscal 2010 revealed a fairly solid performance that supports our thesis that the firm is likely to outperform its peers in difficult economic environments. Results were very close to our expectations, and we are maintaining our fair value estimate.
As European smokers continued to feel the pinch of the slow economy, Imperial's positioning in discount cigarette categories and loose tobacco allowed the firm to grab share. Tobacco revenue grew 3% in the fiscal year, as a 9% increase in loose tobacco volume and higher prices offset a 4% decline in cigarette volume. Despite lower cigarette demand and pressures from rising leaf costs, two headwinds that we expect to be sustained in fiscal 2011, Imperial expanded its operating margin by 100 basis points to almost 17% as a result of distribution cost efficiencies. In line with results from other international tobacco firms, Spain was the weak spot, with volume falling almost 17%, and we expect high unemployment in that country to lead to continued weakness in the first half of fiscal 2011.
As we had expected, volume largely stabilised in Imperial's other core markets. In the United Kingdom, where Imperial is the market leader, volume increased more than 1% and the firm gained share, in part because of Imperial's strong presence at discount price points. However, the results were also notable for a 3% volume growth in premium brand Davidoff, driven by growth in Eastern Europe, perhaps indicating that the long-term uptrading trend may be reappearing in that market. As the economy recovers, however, we anticipate that the premium products of rivals like British American Tobacco (BATS) and Philip Morris International (PM) will gain share at the expense of Imperial's portfolio because of the popularity of their brands. As a result, we think there is limited upside to Imperial's market value, currently trading at 14 times our forward fiscal-year earnings estimate, an enterprise value/EBITDA of 9 times, and a free cash flow yield of 9.4%.